A Dumb Idea: Tax-Exempt OPEB Bonds

They're a bad solution in search of a problem, and they won't stimulate anything.

In the flurry of proposals swirling around Washington last week amid the debates over the stimulus package, some were worthwhile, some were well-intended but misguided, and some were pure pork-barrel. A notorious handful were simply lame, disingenuous and self-serving.

One of the worst ideas of the latter category to surface in the tax-exempt bond policy arena was a naive corporate initiative to spur a public-official letter-writing campaign to advocate tax-exempt status for muni bonds sold to fund retiree medical benefits (OPEB, which stands for "other post-employment benefits"). The ostensible cause was to reduce local taxpayer costs of funding these OPEB benefits -- at the expense of federal taxpayers who are, of course, the same taxpayers. It goes without saying that the lobbyists' real objective was to fatten private-sector wallets. This stuff is even slimier than pork-barrel.

Bad tax policy. The all-too-obvious objective of this campaign was to generate more investment management fees for private interests. Of course, this has nothing whatsoever to do with stimulus for the economy. Nor does it have anything to do with the proper functioning of the municipal bond market. Nor with the efficient operations of the federalist system of intergovernmental finance. The proposals featured in my December column on infrastructure incentives and the more recent February column on guarantees for the muni bond market were far better examples of the kinds of objective professional thinking, policy research and advocacy that makes a positive difference in the field of public finance.

This glorified chain letter encourages a re-write of the 1986 arbitrage laws to permit municipalities to sell tax-exempt bonds in order to shamelessly turn around and make a subsidized profit by investing the money through their retirement plans. The U.S. Treasury said no to that abusive strategy over 20 years ago, and for good reason. Anybody with a smidgeon of historical insight would know, and understand, why this idea should be clobbered Dead on Arrival on Capitol Hill.

PIGS at the arbitrage trough, again? The authority to issue tax-exempt bonds is a treasured right of state and local governments, as well documented in policy statements of the Government Finance Officers Association and other public-finance and state and local public policy associations. When private interests seek to advance their profits by finding loopholes in the system and manipulating public officials to lobby Congress to permit abusive transactions, they undermine the entire logical structure of state and local finance. And that's what this campaign for tax-exemption of OPEB bonds would do. The public-sector groups have been fighting the complexity of federal arbitrage regulations for decades, and this proposal would simply give the Treasury department and the congressional staffs another reason to tell the Joint Tax Committee that the PIGS (as state and local Public Interest Groups are known lovingly inside the Beltway) are back at the arbitrage trough -- trying to make profits by selling tax-exempt bonds instead of building streets, roads, libraries, schools and public infrastructure.

When state and local government officials lose sight of the primary purpose of their tax exemption for bond interest, they erode their credibility in Washington, and put their irreplaceable tax exemption at risk. It's one of many lasting lessons I learned from my time on staff at GFOA and as an advisor to the U.S. Treasury Department staff who wrote several important arbitrage regulations in the late l980s. The state and local government policy associations in Washington understand this dynamic, and are always respectful of the U. S. Treasury position on abusive arbitrage in the tax-exempt market. They don't want to kill the golden goose, after all. So when private interests start meddling -- naively and stupidly -- in intergovernmental tax policies that they haven't bothered to research properly, it gets my goat.

A lousy solution that's looking for a problem. There are already plenty of tools and structures to finance OPEB benefits. Right now, few states and localities have the spare revenues to properly fund their plans, but the actuarial and capital-markets tools are readily available. The real OPEB funding problems are the recession and the sustainability of benefits promised, not the cost of credit. As noted in my previous column on taxable benefits bonds, there may well be a viable market window for OPEB bonds later this year that does not require tax-exempt status. This proposal would slap an exorbitantly expensive band-aid on the problem of properly funding retiree medical benefits, not a solution.

All it takes is one bad apple. So let's not resort to gimmicks now, at the expense of the federal taxpayer and at the risk of municipal governments' credibility on the Hill. All this proposal would do is shift costs from state and local governments to the federal taxpayers in an extremely inefficient way. The revenue loss to Uncle Sam would greatly exceed the cost savings to state and local governments. It would be far more honest for local officials to simply ask for an outright congressional handout to pay directly for public employees' retiree medical benefits, just like General Motors and other private corporations that made promises they now can't keep -- and we know what the American taxpayer thinks of that idea right now.